The Inflation Reduction Act (IRA) was a big step forward for the Biden administration in its efforts to reduce greenhouse gas emissions and promote renewable energy. Its implications could sweep the energy sector, not excluding midstream. S&P Global Ratings analysts have reviewed the most salient points of the legislation, along with other recent proposals, with an eye toward implications for midstream credit quality. This report summarizes our thoughts on the topic.

Permitting Overhaul

The most immediate and impactful driver of midstream credit quality, in our view, is not part of the IRA: it's the now-defunct permitting overhaul bill introduced by Sen. Manchin of West Virginia. While imperfect, the bill, in our view, would have approved the Mountain Valley Pipeline, the 303-mile link between the Marcellus Shale in West Virginia and connections in southern Virginia. This would have provided Equitrans Midstream (BB-/Negative/--) with a boost to its credit quality, once the pipeline was close to being placed into service. The bill was opposed by both parties and pulled in order to advance legislation to keep funding the federal government, and we are now back to a regulatory and legal limbo for the pipeline; however, it illuminates a possible future for permitting reform, one that limits the scope and time frame of environmental reviews of major energy projects such as pipelines, transmission lines, and wind farms. The Manchin bill limited environmental impact studies to not later than two years, shortened the timeline for public comments, and sought to limit states' and tribes' ability to veto projects on water-quality issues through changes to the Clean Water Act.

While we believe this kind of permitting reform will benefit midstream credit quality, the benefit will be somewhat limited. First, we do not foresee many organic large-scale growth projects with the scope of a Keystone XL or MVP that have been significantly delayed or cancelled due to environmental and regulatory headwinds. We also think any reforms that can be passed into law will be unlikely to prevent litigation, which in our opinion is the most meaningful source of construction delays and cost increases.

Carbon Capture And Sequestration Will Move Forward

We believe the IRA increase in the carbon dioxide sequestration credit (45Q) is likely to have a limited impact on carbon capture, utilization, and storage (CCUS) activity in the U.S. in the near term, but could help the development of CCUS projects in three to five years as midstream companies seek partners and delve into the economics. The 45Q credit increased to $85 per metric ton (mt) from $50/mt for carbon sequestration, $60/mt from $35/mt for carbon sequestration with utilization such as enhanced oil recovery (EOR), and $180/mt from $50/mt for direct air capture (DAC). The IRA also extended 45Q to facilities that began construction before the end of 2032 from 2026 previously. While we think the the new 45Q could accelerate investment in new facilities with the goal of lowering costs through scale, we also believe infrastructure funds and private equity sponsors could step into this arena as projects scale and become more economic. Trace Midstream, a privately held midstream infrastructure developer, received a $400 million equity investment from its sponsor, Quantum Energy Partners, to focus on developing CCUS assets. That said, we think most initial investments will come from larger midstream companies with a more diversified asset footprint who will seek partnerships with the more significant carbon emitters. The table below includes some projects already in commercial operations and a few of the more recently announced CCUS ventures with companies that we rate. We expect more announcements in the near term, but believe the leap to full scale operations still several years away.

Table 1

Hydrogen Is a Longer-Term Play

The IRA provides for a new production tax credit (PTC) for clean hydrogen of up to $3/kg of hydrogen (H2), as long as CO2-equivalent emissions are not greater than 4kgCO2-eqivalent per kilogram of hydrogen produced (eq/kgH2). The credit will decrease as emissions increase over the lifecycle of the hydrogen producer. A producers can only receive the full credit of $3/kg of hydrogen when lifecycle emissions are not greater than 0.45kgCO2-eg/kgH2 and only 20% of the full credit when emissions reach 4kgCO2-eq/kgH2.

We believe midstream companies' role as it relates to blue or green hydrogen will take shape over the longer-term and will be around the transportation and storage of hydrogen using natural gas pipelines and storage facilities over the next decade. The industry will have to solve some of the logistics issues of moving hydrogen, including that hydrogen can make steel pipes brittle and a greater risk of leakage as hydrogen molecules are smaller than methane. Most hydrogen initiatives are in very early stages of development and are focused on blending hydrogen with natural gas using existing pipelines, and will not be a credit or ratings driver anytime soon.

Many companies have started down the path already. The Williams Cos. have partnered with others through their corporate venture capital program with a $40 million investment in Aurora Hydrogen, to develop a technology that converts natural gas to hydrogen with zero carbon dioxide emissions, with a goal of a prototype plant by 2023. New Fortress Energy Inc. is also working on converting natural gas to blue hydrogen. Larger diversified companies like Kinder Morgan Inc., TC Energy Corp., and Enbridge Inc., as well as others are blending hydrogen into the natural gas stream and will likely scale these features as they become more economic and the demand increases.

The Minimum Book Tax On Profits And Excise Tax On Buybacks

The IRA's two main tax provisions that will begin in 2024--a 15% minimum tax on corporate profits and a 1% excise tax on share buybacks--is unlikely to have a harmful impact on the credit quality of the midstream companies that we rate. The 15% minimum tax on corporate book profits, which the Joint Committee on Taxation estimates will raise about $313 billion over the next decade, will likely only affect a limited number of midstream companies. The minimum book tax applies to companies generating average annual adjusted financial statement income (AFSI) as opposed to profits on a tax accounting basis of greater than $1 billion over the prior three years. Kinder Morgan stated it expects to be subject to the tax in 2023 and likely begin larger payments in 2024. The Williams Cos. does not expect to be subject to payments in 2023, and we believe ONEOK Inc. will eventually be affected by the minimum tax too. That said, the net present value impact of these future payments is unlikely to change our view of the companies' financial profiles.

We believe the 1% excise tax on share buybacks would apply more broadly that the minimum corporate tax provision, particularly as midstream companies are using more of their free cash flow to buy back shares to reward shareholders than increasing the dividend. However, the buyback tax does add a third layer of taxation on earnings (including corporate and capital gains taxes) returned to shareholders, which could make companies think through the cost of buybacks versus dividends and how their decisions may affect the cost of capital.

Midstream Resiliency Vs. Long-Term Renewable Growth

While the IRA will accelerate growth in the renewable energy supply using wind, solar, and battery storage, we hold firm to our belief that the transition will take time, with midstream companies playing a role in that evolution. As recent global events have made clear, hydrocarbons like crude oil and natural gas still anchor the global economy. We believe traditional energy sources will remain a vital part of most economies for the next several decades, until technological advances in battery storage can displace significant amounts of natural gas--the default back-up of today--is a reality. That said, we also think midstream companies will innovate and continue to focus on becoming more transparent and efficient at the "E" of the ESG strategy, by reducing the industry's carbon footprint and promoting more sustainable fuels as they use their logistics networks to promote cleaner and secure energy sources in the future.